Escalating trade war fears drive markets
The strong Chinese response to Trump's tariff threats over the weekend has ratcheted up the tension in financial markets. Stocks worldwide are selling off as safe assets like government bond yields drop to new lows.
C
urrency markets continue to trade relatively calmly in comparison to most other assets, though the Mexican peso did lose all its 2019 gains to end down over 3% against the greenback after Trump's threats. Sterling was once again the G10's worst performer, as traders became jittery about the political chaos there and the lack of any prospects for resolving the Brexit impasse.

Politics and the potential impact of a trade war on economic growth are swamping economic data and policy news as factors driving the market. Strategists have been busy revising their G10 central bank outlooks downwards, and calling for interest rate cuts everywhere real rates are positive, particularly the US. We think it's wiser to wait for actual data to reflect this hypothetical slowdown, and are for now keeping our call for no moves either way from the Federal Reserve.

This week the key event will be the ECB June meeting on Thursday. US non-farm payrolls on Friday will provide some end-of-week volatility as well.

Major currencies in detail


GBP


Brexit uncertainty keeps increasing. Polls in the UK are predicting serious political upheaval, with both the Tories and Labour being surpassed by parties with a clearer position on the Brexit issue: Liberal Democrats on the Remain side and Farage's newest political vehicle on the Leavers' side.

The clock towards the new October deadline is running again, with essentially no sign that any progress is being made. Markets are clearly unhappy with this state of affairs, and Sterling finished the week again at the bottom of the G10 league. No critical news is scheduled to be released this week, so political headlines should continue to drive pound performance.

EUR


The Euro is holding up relatively well in the face of financial risk aversion and the threat of trade wars. This will be a busy week for the common currency. In addition to the critical June ECB meeting, tomorrow we get a first look at May inflation. Consensus is expecting a fall back to the disappointingly low numbers of the first quarter of 2019.

Most strategists also seem to be expecting a very dovish message from President Draghi on Thursday. This dovish consensus, together with the extremely short Euro positioning in markets creates the conditions for a Euro rally if either the data or ECB communications are more positive than markets expect.

USD


While a chorus of strategists and economists are busy calling for Federal Reserve cuts to the overnight interest rate, incoming data tells a different story.

Overall, the theme of the last few years, with steady economic growth, strong job creation, real wage gains and quiescent inflationary pressures remains unchanged, in our view. Trade tensions and tariffs are a medium term negative, but we think that as and when the economic and financial damage is revealed the Trump administration will come under enormous pressure to reach agreements. Therefore, we are maintaining our call for no cuts, and think that Friday's employment report will provide further support for our view.
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